NONPROFIT FINANCIAL STATEMENTS

by
Kelly Bourgeois

A MASTER’S CAPSTONE PAPER

Presented to the Arts and Administration Program
of the University of Oregon
in partial fulfillment of the requirements for the
degree of Master of Science in
Arts and Administration

June 2003
Kelly Bourgeois, 2003

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 Table of Contents

Preface

Purpose 1

Historical Background 2

Background of Financial Statements 4

Analysis of Financial Statement 6

Significance 7

Assumptions 8

Accounting Methods 9

Cash Flow Worksheet and Statement 15

Cash Flow Worksheet Example 16

Cash Flow Statement Example 18

Balance Sheet 19

Balance Sheet Example 21

Operating Statement 24

Operating Statement Example 26

Budgets 28

Budget-Projected Revenues Example 29

Budget-Projected Expenses Example 31

Flexible Budget Example 33

Performance Based Bud get 34

Conclusion 35

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 Purpose

The purpose of this capstone project is to describe and analyze the significance of

select financial statements of nonprofits. By examining a variety of literature and by

summarizing material acquired from three capstone courses taken in the Arts and

Administration masters program, I will be able to provide recommendations for utilizing

financial statements for nonprofit financial management. The significance of this capstone

project will be that it provides an analysis of the importance of financial data that is

applicable to arts organizations.

Historical Background

Peter Hobkin Hall argues in Historical Perspectives on Nonprofit Organizations,

that during the colonial period “…neither philanthropy nor voluntary associations existed

then in a recognizably modern form” (1994, p.4). Still, colonists supported charitable

purposes, with the majority of the money given though donations to public institutions.

(Hobkin,1994) “Only in the mid-eighteenth century did the political, economic, and legal

conditions favorable to the development of voluntary associations and private

philanthropy…assume significance” (Hobkin, p.6).

After 1789, the Constitution viewed donations as contractual relationships to public

entities and thus encouraged and supported such contributions. This interpretation of the

Constitution encouraged the idea that people had a private responsibility to support the

public good.

In 1874, Charles Eliot defended tax exemption of public institutions and broadened

the scope of tax-exempt organizations. His arguments also helped increase the size of

acceptable tax-exempt gifts (Hobkin, p.10). Charitable institutions grew enormously

4
because of these new regulations. Charitable trusts, community chests, and foundations

emerged during the late 19th century and “would substitute for equality of condition,

equality of opportunity and, suffused with an ethos of service, would invest social,

economic, and political life with a sense of common purpose” (Hobkin, p.17). The number

of charitable institutions in the United Sates continued to grow.

World War I demonstrated the importance of private support of the public good

through public-private partnerships. The war provided an opportunity for major

fundraising and created partnerships between public entities such as the Red Cross and

private businessmen such as Herbert Hoover (Hobkin, p.17). Hoover’s efforts were based

on “voluntary cooperation with the community” which would develop an exchange of

information between social organizations, scientific institutions, and economic entities

(Hobkin, p.18). Hoover’s ideals influenced Roosevelt’s formation of the National

Recovery Administration, an early New Deal program.

Because of increased taxation modern nonprofits proliferated in the 1930’s.

Businesses and wealthy citizens now had major incentives to give to organizations.

Nevertheless, as Salamon points out,“ The Great Depression of the 1930s made clear…that

private and localized system of aid, however well intentioned, was not capable of providing

on its own the protections that an urban- industrial society required” (Salamon, p.58). The

New Deal administration therefore enacted a multitude of programs: old-age pensions

(Social Security), unemployment insurance, and needs-tested cash assistance (Salamon,

p.58). Although these programs represented major steps to providing aid to all citizens,

they fell short of intended goals and were characterized by “patchy coverage, limited

funding, local and state government dominance, and educational salience” (Salamon, p.59).

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 During the 1930’s changes in economic philosophy, taxes and budgeting practices,

foreign policy, legal doctrines, and demographic factors intersected to create a distinctively

American version of the welfare state (Hobkin, 1994, p.19). “Keynesian economic theory

pointed to the ways in which taxing, spending, and borrowing could be used to influence

the economic activities from which the government drew its revenues” (Hobkin, p.19) and

encouraged individuals to give money to for-profit and nonprofit activities. In turn,

enormous amounts of money were transferred into foundations and nonprofits.

Beginning in the 1940’s with the governmental system unable to provide universal

assistance because of World War II, the general public turned to nonprofits to play a

significant role in the public social welfare system. Legislation passed in 1943 made

income taxation universal and created more incentives for the public to give to charitable

organizations. (Hobkin, p.19). The government played a role in funding the growth of

charitable organizations by giving businesses and individuals additional incentives to give

to charitable organizations. The government also provided grants and contracts that

stimulated the growth of nonprofits.

The “Great Society” of the 1960’s made major strides in social reform including:

employment training for the disadvantaged; Medicare, a national health insurance plan for

the elderly; Medicaid, health care for the poor; networks of education programs in low-

income neighborhoods; and a cost-of- living adjustment added to the Social Security

program (Salamon, p.61). In addition, Congress established the National Endowment for

the Arts and the National Endowment for the Humanities in 1965. The evolution of the

welfare system was characterized by increased spending on middle-class programs such as

pensions and health thereafter little aid was provided for low- income people or the poor.

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 During the 1970’s, the continued pattern of patchy coverage still forced the

government to look towards the nonprofit sector to provide social services for the general

public. Nonprofit organizations thrived in this environment by receiving government aid

through various applicable programs such as Medicare, research grants, and local and state

government monies.

This growth period was cut short in the 1980’s with a new administration that cut

education, income assistance, and social service programs and moved social program

money into health care, housing, and pension plans. The purpose of this shift in funding

was to encourage the growth of nonprofits in areas that had been supported by the

government. It actually refocused social services on the middle-class and encouraged for-

profit corporations to compete with nonprofits. Nonprofits were able to continue to

provide services through into the 1990’s through increased health care costs and a boosted

demand for services provided by nonprofits paid through business income.

Overall, even with the 1980’s retrenchment, government aid to nonprofits

increased. Presently, nonprofits continue to receive a majority of their funding through

government agencies while facing increased competition from for-profit entities. As the

history of nonprofits demonstrates, providing social services for the general public will

continually be affected by government policies and the demand for services from the

general public. Increased demand with increased competition will force nonprofits to seek

private funding and become financial managers.

Background of Financial Statements

In Financial Accounting and Managerial Control for Nonprofit Organizations

(1994), Regina Herzlinger and Denis Nitterhouse state: “The size of the private nonprofit

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sector has been pegged at 970,000 nonprofit organizations, with 7.4 million employees and

contributions of $104 billion” (p.1). The competition for funds from governmental

agencies and foundations has necessitated clarity and consistency in financial statements

provided by small nonprofits.

Harrington Bryce argues, “The principle purpose of a nonprofit organization is (1)

not to make a profit, and (2) not to benefit individuals as owners, but to advance the

welfare of society” (p.3). In short, the principle purpose of a nonprofit is to realize its

mission of public service. It must do this within ethical and accountable financial

management practices established by the Financial Accounting Standards Board (FASB),

the state, and the Internal Revenue Service (IRS). Primarily the organization must produce

three important annual financial statements: the statement of financial position (balance

sheet), the statement of activities (operating statement), and the statement of cash flow.

Together, these reports, along with an evaluation by the chief executive officer, reflect the

performance and financial condition of the organization.

The balance sheet, or statement of financial position, is a snapshot of the

organization’s financial condition on a particular date. The balance sheet shows the assets

versus the liabilities of the organization and documents the organization’s net assets (or

what the organization has left after you subtract the liabilities from the assets). At a

minimum, the balance sheet must break down the net assets into unrestricted, temporarily

restricted, and permanently restricted assets.

In contrast, the income statement, or statement of activities, summarizes the

financial activities over a period of time. The income statement addresses how the

organization’s net assets, of three categories mentioned above, have changed and whether

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there were times when one net asset class moved in relation to another. As Thomas Wolf

argues in Managing a Nonprofit in the Twenty-First Century, “Armed with the income

statement…it is possible to determine whether the organization had a surplus, a deficit,

made any unusually large expenditures, or had any revenue windfalls” (1999, p.215).

Finally, the statement of cash flows reports how the organization’s cash position

changed during the year. In essence, the statement of cash flows provides information

about cash receipts and cash disbursements of the organization (Hummel, p.78).

The three financial statements are used together to project and analyze the fiscal

health of an organization. Many states and funding organizations require nonprofits to

provide these financial statements to address questions about their financial activities. The

financial statements may also be used to compile a formal audited statement, prepared by a

certified public accountant, that complies with FASB standards.

Analysis of Financial Statements

This analysis will provide examples of internal and external vulnerabilities

indicated through the financial statements, future improvements that could be made to

increase financial stability using budgets, and the vital that role the three documents play in

the health of a nonprofit organization.

The difference in analyzing a nonprofit’s balance sheet and a for-profit’s balance

sheet is the reporting of the organization’s equity. Equity derives from the nonprofit’s

generated earnings from its operations compared to what the organizations owes (Thomas,

1994, p.405). Earnings retained are recorded as net assets or fund balance. In general, the

more net assets an organization has retained the greater the organization’s net worth

(Cumfer, C.& Sohl, K., 2001, p.519). This paper will analyze issues arising from

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organization’s negative or positive net worth. The analysis will also provide information on

fund accounting or the breakdown of net assets into unrestricted net assets, permanently

restricted net assets, and temporarily restricted assets. The analysis of the income statement

will discuss the ratio of expenses during a given period of time to the projected or budgeted

expenses during the same period of time. As argued by John C. Thomas in The Jossey-

Bass Handbook of Nonprofit Leadership and Management, the income statement “explains

the change in operating equity between two balance sheets”(1994, p.406). This information

can enable the organization to determine if projects, programs, or other unforeseen

expenses incurred have affected the organization as a whole. Analysis of the cash flow

statement allows organizations to gather information on the income and expense

management of the organization.

An organization can determine if net income and net assets are accurate at the end

of the year by analyzing the statement of cash flow to determine if there are any unpaid

expenses or if revenue will be generated at a later date. In addition, by analyzing the unpaid

expenses, an organization can budget appropriately for the given financial period (Olenick,

A. & Olenick, P., 1991, p.136).

Significance

As Joan Hummel states in Starting and Running a Nonprofit Organization (1996),

“Increasingly, funders, government bodies, and various auditing agents are requiring that

the organizations they audit follow program accounting methods”(p.76). Nonprofit

organizations dependent on federal and state governments are required to have financial

verification and established accounting procedures to receive monies from such agencies

(Grobman, p.113, 2002). Constituencies dependent on nonprofit organizations’ programs

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are also affected by consistent, detailed record keeping of financial statements that indicate

the costs of services and programs provided by an organization. Through cost analysis,

nonprofits can make plans to provide more effective services and programs, or conversely,

decide to cut services and programs because of the costs involved. In essence, good

financial record keeping affects not only the internal aspects of the organization but also

external partnerships.

Unfortunately, the contributions to and development of nonprofits are often

hindered by the public perception of inadequate and unreliable quantitative and qualitative

measures of an organization’s success. Lester Salamon states, “…nonprofit organizations

generally lack meaningful bases for demonstrating the value of what they do” (p.174). One

way to provide reliable and adequate data is through the three detailed financial statements

described above.

The key questions that this paper will address through information provided by the

three capstone courses and literature review are: What are the fundamental financial

statements? What elements compose these statements? How does one analyze information

provided by these statements? What are the impacts of each statement?

Assumptions

This analysis assumes the following:

§ Financial managers of nonprofits want to understand the financial process of

developing and evaluating financial statements.

§ Financial accountability is key to successful management of a nonprofit

organization.

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 § The cash flow, income, and balance sheet are three key financial statements of a

nonprofit organization.

§ Nonprofit managers use financial statements to determine income, expenses, assets,

and liabilities of an organization.

§ Financial statements are utilized to complete grant applications, state and federal

forms.

§ Leaders of smaller organizations need to understand and develop financial

statements and cannot afford to have full-time technical/professional staff to

facilitate financial management.

§ Nonprofits will continue to develop and use financial statements to facilitate the

mission, goals and objectives of the organization.

§ Nonprofit managers will follow accounting principles and have high ethical

standards.

Accounting Methods

There are three types of major accounting methods for nonprofits: cash basis

accounting, accrual-based, and a modified cash accounting system (Dreezen, C. & Korza,

P., 1998, p.246). To determine which accounting method is used by a nonprofit, the

organization must first choose to show when revenues or expenses will be recorded and

then determine which system will reflect the financial condition of the organization in a

more accurate manner.

Most people are familiar with cash basis accounting because it is synonymous with

their own checking and savings account. When following a cash basis accounting system

“financial transactions are recorded only when cash changes hands” (Wolf, 1990, p.170).

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As Thomas Wolf explains: “When a person receives money and deposits it in the bank, the

deposit is recorded as income and is added to the bank account balance. [Inversely], when

cash is withdrawn from the bank…the transaction is recorded as an expense” (Wolf,

p.170). In cash basis accounting receivables and payables are not recorded. Although this

system of accounting is quite straightforward it often results in misleading financial

information because it tells nothing about what the organization may owe or is owed during

a given period of time. Arnold and Philip Olenick argue in A Nonprofit Organizations

Operating Manual (1991), “The only good argument for recording and reporting economic

events only when cash is immediately involved (cash basis) is its familiarity and

simplicity” (p.217).

The second form of accounting is the accrual-based accounting method. The

accrual method is not as simplistic as cash basis accounting but it does “paint” a picture of

the overall financial health of the nonprofit. Accrual method accounting takes into account

“all committed income and expenses, whether or not they have been actually received or

paid, are entered in the books” (Dreeszen, C. & Korza, P., 1998, p.246). Most people are

familiar with the accrual method of accounting because it is synonymous with credit-card

transactions and payments. The system of recording not only what has been purchased and

paid for but also what is owed to the credit card company is a simplified version of accrual

accounting.

Grants are typically entered into the accrual system of accounting as income once a

confirmation of the grant is received. The organization may not actually have the money in

their account but will receive the money at a later date and therefore can record the grant as

income. On the other hand, expenses will be recorded in the same fashion as accounts

13
payable and will reflect the actual amount owed at a given time and will include all

activities of the organization not just cash transactions. “The accrual basis classifies

revenues and expenses by taking into account not only the accounting period in which the

bill is paid, but more importantly, the period in which the activity involved occurred”

(Olenick, A. & Olenick, P., 1991, p. 219). With the accrual method specific revenues and

expenses are recognized as a current, accrued, or deferred revenue or expense. Arnold and

Philip Olenick have provided a synopsis of revenues and expenses and the classification

used to identify each type:

1) Current revenue or expense, if all of it was earned or incurred as well as used

during the current period and the amount was all paid for in the current period.

2) Accrued revenue or expense, if earned or incurred in the current period, which

benefited, to the extent not paid by the end of the period.

3) Deferred revenue or prepaid expense, to the extent paid in advance during the

current period, where all or part of it will benefit a future period (1991, p.219).

An example of current revenue is money exchanged for a ticket to a play. The

revenue generated from this transaction is considered current revenue because the ticket is

used for tonight’s play. Therefore, the revenue and expense happened within the same

accounting period. Accrued revenue, on the other hand, might be dues or subscriptions

where the amounts remain uncollected after related services have been performed. Often

accrued revenue is linked to delinquent accounts, uncollected grants, and program service

fees for which the client has not paid for the service that have been performed. Finally, an

example of deferred revenue is when pledges, dues or subscriptions are received in advance

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and specified to be used during a future period. Pledges are accrued and deferred during

the period not in use and amortized over the period in which it applies.

A third accounting method is the modified cash basis of accounting. “According to

this system, the books are kept on a cash basis except for a few accounts tha t are kept on

accrual and that are usually updated only at the end of the month or at financial reporting

time” (Wolf, 1991, p.171). Often the accrual accounts in the modified cash accounting are

reoccurring or important outstanding obligations of the organizations. Many organizations

use the modified cash basis of accounting to “rectify” their bookkeeping entries to reflect

that actual revenues and expenses of the organization and to create an opportunity to

summarize financial statements in an accrual me thod.

To avoid accounting problems, a nonprofit must review the entire organization as a

whole and implement an accounting program suited to its individual needs. To do this an

organization must address five questions: What personnel are responsible for each duty?

What are the safety mechanisms in place for the organization’s resources? What approval

and authorization systems are needed or are in operation? What methods are available to

verify the safeguards? Does the organization have any insurance to cover losses? (Wolf,

1991, p. 174) (Olenick, A. & Olenick, P., 1991, p. 236-39) The organization must also look

at the size and scope of the organization’s activities. As Arnold and Philip Olenick argue,

“Different kinds of users differ in their level of expertise, knowledge, and understanding,

and in their specific information needs” (1991, p.216). Finally, an organization should

determine its accounting purposes at the various levels.

Choosing a type of accounting system for a nonprofit can be a difficult and vexing

task. A nonprofit must remember that if it chooses to use a modified or strictly cash basis

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accounting method that at least once a year the system must be modified to an accrual

method. (Wolf, 1991, p. 172) This modification must take place to reflect the financial

solvency of the entire organization and its activities. The accrual method is mandated by

the generally accepted accounting procedures or GAAP. As Thomas Wolf states, “It should

be obvious that knowing the financial condition of an organization is more revealing than

knowing its bank balance” (1998, p.171).

Each accounting method has advantages and disadvantages for its use by a

nonprofit. An organization should always seek the help of professionals to assist it in

implementing and, if possible, administrating its accounts. In the end, the best system is a

system that gives the members of an organization control over its financial health and

portrays this health through their records. Craig Dreeszen and Pam Korza caution

“…picture yourself at audit time trying to explain how money was spent and where money

came from” (1998, p.247).

Each component of a nonprofit organization’s existence, such as the organization’s

programs and projects, is dependent on the organization’s financial feasibility. Financial

feasibly is accounted for through a variety of financial statements, primarily the balance

sheet, cash flow and operating statement. One of the principle differences in nonprofit

financial statements compared to for-profit entities is that the overall objective of a

nonprofit is to realize its socially desirable goals and objectives for the community it

serves, rather than to realize a net profit.

Nonprofits can only serve their goals and objectives if they have sufficient cash to

provide for various programs. This dependence upon cash flow has created a heavy

responsibility for nonprofits to account for the resources they have received. Nonprofit

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fund accounting has enabled organizations to segregate assets into categories by the

restrictions placed on their use. Dreeszen and Korza state, “Unlike the systems used by for-

profit corporations in which “owner equity” is shown, a nonprofit tax-exempt entity reports

a fund balance on its balance sheet” (1998, p.245). Other differences inc lude: fixed assets

may not be recorded by a nonprofit; pledges, contributions, and other noncash

contributions can be legally enforceable and recorded as an asset if the organization

chooses to collect them; and smaller nonprofits can choose to use the cash basis accounting

instead of the accrual method (Connors, 1993, p.789). These differences reflect the unique

nature of formulating financial statements for nonprofits and enable nonprofits to manage

their assets and record them in an accurate and understandable manner.

When assessing the financial health of a nonprofit, the executive director and board are

responsible for overseeing that the organization’s financial records are maintained

completely and appropriately and clearly state what has happened during a given period of

time. Tracy Daniel Connors argues that financial statements should have five

characteristics:

1. They should be easily comprehensible so that any person taking the time to study

them will understand the financial picture.

2. They should be concise so that the person studying them will not get lost in detail.

3. They should be all- inclusive in scope and should embrace all activities of the

organization. If there are two or three funds, the statements should clearly show the

relationship among the funds without a lot of confusing detail involving transfers

and appropriations.

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 4. They should have a focal point for comparison so that a person reading them will

have some basis for making a judgment. In most instances, this will be a

comparison with a budget or with figures from the corresponding period of the

previous year.

5. They should be prepared on a timely basis. The longer the delay after the end of the

period, the longer the period before corrective action can be taken (1993, p.766).

In addition, statements should reflect the organization’s position as accurately as

possible. Miscellaneous or small line items should not be grouped together into a “slush”

account, which can cause confusion and mislead others when reviewing the statements.

Cash Flow Worksheet and Statement

A cash flow worksheet can aid an organization by reviewing what monetary inflows

and outflows the organization will sustain during a given period of time. Rather than

revenues and expenses a cash flow worksheet records line items as receipts and

disbursements. Specifically, the cash flow worksheet can help an organization determine

whether there is adequate cash available for an organization to meet its expenses during the

month. The difference between an annual budget and a cash flow worksheet is that the cash

budgeted in the worksheet addresses expenses that need to be met during a given month.

An annual budget is not concerned with the specific time of the expenses but rather the

expenses over the entire year.

By projecting inflows and outflows of cash an organization can determine if there

will be a cash flow problem over several months. In the example of the ABC Nonprofit

Cash Flow Worksheet, October and November have a surplus of cash. However, by

projecting the cash flow of the organization over four months the organization can tell that

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it will sustain a deficit in December and January. In addition, the organization can spot

certain areas that are causing the deficit such as the loss of revenues from grants and the

increased expenses incurred in November for rent. These are just two examples of why

ABC Nonprofits is projecting a deficit in cash during December.

Cash Flow Worksheet for ABC Nonprofit

10/01/03 to 1/31/04
October November December January
Opening Cash 500 7,300 5,000 -1,020
Expected Receipts
Client Fees 250 300 300 300
Meyer Grant 2,000 1,000 1,000 0
Government Grant 1,000 0 0 0
Sales 1,500 2,000 2,000 1,500
Donations 3,000 2,500 2,000 1,500
Other Grants 5,000 3,000 0 0
Receipts Total 12,750 6,300 3,300 3,300
Loans Received 0 0 0 0
Total Cash Available 13,250 13,600 8,330 2,280
Expected Disbursements
Net Payroll 2,000 3,000 3,200 3,000
Federal Withholding &FICA 700 1,000 1,100 1,000
Sate Withholding 300 500 6,00 500
Workers Compensation 250 400 450 400
Unemployment 250 300 450 400
Health Plan 400 500 800 700
Rent 600 1,200 1,200 1,200
Utilities 250 500 800 700
Office Supplies 200 300 200 100
Insurance 300 400 400 400
Postage 200 300 300 200
Program Supplies 300 400 100 200
Printing 100 100 250 100
Other 100 200 300 0
Loan Repayments 0 0 0 0
Total Disbursements 5,950 7,900 8,950 7,700

Ending Cash 7,300 5,000 -1,020 -6,620

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 A cash flow statement, simply put, enables a nonprofit to determine where it spent

its money and where the money came from. The cash flow statement reviews “(1) the net

effect of operations (revenues minus expenses), i.e. the operating surplus…(2) non-revenue

funds received, such as loans and advances; (3) non-expense items paid, such as payments

on loans or installments, or for inventory, prepaid expense, equipment, or security deposits;

(4) changes in accounts receivable and accounts payable balances” (Olenick, A. & Olenick,

P., (1991), p. 372). The cash flow statement is different from an operating statement

because it reflects the cash situation of the organization in its entirety, whereas the

operating statement reflects a current given period of an organization’s activities as

reflected by their revenues and expenses.

The cash flow statement, also called the Statement of Activity provides vital

organizational information as Robert Anthony and David Young point out:

Revenues and Expenses are measured by what is called the accrual concept.
According to this concept, revenues is recorded when it its earned, and expenses are
recorded when they are incurred. These are not necessarily the same as the amount
of cash received or paid out. Because of this, entities prepare a third statement—the
statement of cash flows (SCF)—that explains the reasons for cash changes. The
SCF classifies cash changes into three categories: operations, financing, and
investing (1994, p.406).

Cash flow statements can easily be prepared by analyzing the beginning balance

sheet with the ending bala nce sheet of a specific period. Subtracting the beginning balance

sheet from the ending balance sheet will indicate the changes in the balances for each

period or the cash flow for the organization. Cash or gifts of any kind with a restricted

purpose must be segregated from those that are general or unrestricted assets and

temporarily restricted funds.

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Example of Cash Flow Statement for BookGood Nonprofit**

Cash Flow from Operating Activities:

Cash Received from Unrestricted: $ 400,000.00
Temporarily restricted Contributors: $ 400,000.00
Cash Received from Service Recipients: $ 30,000.00
Grants Paid: $ (100,000.00)
Cash paid to Employees and Supplies: $ (700,000.00)
Interest Paid: $ (13,000.00)
Interest and Dividends Received: $ 25,000.00
Net Cash from Operating Activities: $ 42,000.00

Cash Flows from Investing Activities:

Purchase of Investments: $ (30,000.00)
Fixed Asset Purchases: $ (150,000.00)
Net Cash Used for Investing Activities: $ (180,000.00)

Cash Flows from Financing Activities:

Addition to Endowment: $ 45,000.00
Issuance of Long Term Debt: $ 150,000.00
Net Cash from Financing Activities: $ 195,000.00

Net Increase in Cash: $ 57,000.00

Beginning Cash Balance: $ 150,000.00
Ending Cash Balance: $ 207,000.00

Reconciliation of change in net assets to net

cash
Provided by operating activities
Change in Net Assets: $ 100,000.00
Adjustments
Depreciation Expense: $ 3,000.00
Restricted Contributions to Endowment: $ (30,000.00)
Increase in Pledges Receivable: $ (45,000.00)
Increase in Refundable Advances: $ 10,000.00
Increase in Grants Payable: $ 20,000.00
Decrease In Accounts Payable: $ (7,000.00)
Increase in Prepaid Expenses: $ (2,000.00)
Unrealized Gains in Long-Term Investments: $ (8,000.00)
Net Cash Provided by Operations: $ 41,000.00
**Each of the areas is described below.

Cash Flows from Operating Activities. The area details the unrestricted and

temporarily restricted funding of the organization. This includes unrestricted and

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temporarily restricted cash inflows and outflows. The main body of the ABC Nonprofit

cash flow statement is an example of the direct method of accounting that restates the

temporarily and unrestricted income on a cash basis. The reconciliation at the bottom of

the figure is an example of the indirect method of accounting. This method begins with the

change in net assets from the Statement of Activities (Income Statement or Operating

Statement) and converts the amounts from the accrual method to cash basis accounting.

Most nonprofits will utilize the indirect format to depict the organization cash.

Cash Flows from Investing Activities. This area depicts the cash inflows and

outflows that arise from long-term assets and investments.

Cash Flows from Financing Activities. This area depicts the organization’s cash

inflows and outflows from financing activities such as receipts and repayments to creditors

or donors. This area is for permanently restricted funds that have a set of requirements that

need to be completed by the organization before the money may be used.

When and organization completes the three sections of the cash flow statement the

net increase/decrease in income explains how the cash has changed during the given period

of time and shows the current organizations current cash balance.

Balance Sheet

The organization’s balance sheet is one of the most fundamentally important

documents a nonprofit can provide for use in its internal management. The balance sheet

establishes financial information to external entities. The balance sheet is often referred to

as the Statement of Financial Position or Statement of Financial Condition.

The balance sheet complements the cash flow statement because “the cash flow

statement tells us what funds we expect to have on hand to pay bills and other obligations

22
as they come due. . . the balance sheet report[s]...its current financial situation” (Olenick,

A. & Olenick, P., 1991,p.352). In other words, the balance sheet describes what you own,

such as equipment and cash (assets), compared to what you owe, such as loans (liabilities).

As argued by Elizabeth K. Keating in How to Assess Nonprofit Financial Performance,

“The accounting system for nonprofits is designed to capture the economic activities of the

firm and its financial position. The financial statements are constructed based on the

‘Accounting Equation’ in which: Assets = Liabilities + Net Assets” (1991, p.21). The

difference between the assets and the liabilities provides information on the organization’s

net assets.

Management can scrutinize several areas on a balance sheet:

Assets

o The organization’s fixed assets such as land, buildings, vehicles, furniture, and

equipment

o Inventory (including supplies and merchandise)

o Expenses paid in advance for future service or prepaid expenses

o Cash balance on the date of the balance sheet

o Amounts due to the organization or receivables

o Investments

o Other assets such as security deposits, utilities, etc.

(Olenick, A. & Olenick, P., 1991, p. 353).

Liabilities

o Amounts owed for services rendered or accrued expenses

o Accounts payable, such as goods received from a supplier

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 o Payments (installments) for equipment

o Taxes payable

o Loans such as short- or-long-term loans

o Unearned revenue such as payments received for services that have not been

performed

o Other liabilities such as mortgages (Olenick, A. & Olenick, P., 1991, p. 353).

Once an organization has reviewed the items listed above, it can address several

important areas: solvency, resources, and outstanding liabilities. The organization is

solvent if the current assets are greater than the current liabilities. A good rule of thumb is

to maintain a current ratio of 2:1, assets to liabilities. If liabilities are greater than assets,

the organization could face or has faced severe financial problems.

The second step in reviewing the balance sheet should be to look at the resources

owned by the organization. By reviewing its resources, management can determine if there

are any assets that could potentially be used to supplement the payment of maturing debts.

Finally, management should look at what the organization owes and determine

when these outstanding liabilities are due. The most common types of liabilities for an

organization come from accounts payable, grants payable, refundable advances, dues to

third parties, long-term debt, unrestricted assets, temporarily restricted assets, and

permanently restricted assets (Keating, 1991, p.30-31).

Balance Sheet for ABC Nonprofit**

Year Year
Assets % Per Year* 2000% Per Year* 2001
Short Term Assets
Cash 24.4 $100,000.00 15.63 $ 75,000.00
Pledges Receivable 18.29 $75,000.00 10.42 $ 50,000.00
Prepaid Expenses 2.44 $10,000.00 1.04 $ 5,000.00
Long Term Assets

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 Investments 12.19 $50,000.00 41.67 $ 200,000.00
Fixed Assets 42.6 $175,000.00 31.25 $ 150,000.00
Total Assets $410,000.00 $ 480,000.00

Liabilities and Net Assets

Liabilities
Short-term Liabilities
Accounts Payable 20.9 $37,000.00 27.13 $ 35,000.00
Grants Payable 14.12 $25,000.00 18.6 $ 24,000.00
Refundable Advances 8.5 $15,000.00 7.75 $ 10,000.00
Long-term Liabilities
Long Term Debt 56.5 $100,000.00 46.51 $ 60,000.00
Total Liabilities 43.17 $177,000.00 26.87 $ 129,000.00
Net Assets
Unrestricted 42.92 $100,000.00 42.76 $ 150,000.00
Temporarily Restricted 14.16 $33,000.00 14.53 $ 51,000.00
Permanently Restricted 42.92 $100,000.00 42.74 $ 150,000.00
Total Net Assets 56.83 $233,000.00 73.13 $ 351,000.00
Total Liabilities and Net Assets $410,000.00 $ 480,000.00
*An organization would not include percent of year. This is an example of an internal balance sheet that
allows the organization to look at what percentage of assets and liabilities are going to each line-item.
**Each of these areas is described below on the balance sheet.

Balance Sheet Assets

Cash. Liquid funds or funds such as U.S. Treasury bonds on deposit in the bank.

An audited financial statement requires that restricted cash (or any other asset) with a

donor- imposed restriction which limits its long-term use must be classified in a temporarily

restricted or permanently restricted account.

Pledges or grants receivable. These are amounts that have been committed by an

outside or external donor to the organization. Pledges and grants should be recorded as the

amount the nonprofit expects to receive or the net realized value. Nonprofits should not

report the full or gross amount because the line item could be overstated.

Prepaid expenses. These are costs paid in advance for receiving goods, services, or

benefits for the organization. This type of asset will decline in value as the asset is

consumed by the organization.

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 Investments. The refers to valuation of the organization’s stocks and bonds. The

amount that should be recorded is the fair market value on the date that the financial

statements are prepared. However, on a tax return, this can the amount can be the historical

cost of the investments, the lower fair market value or historical cost, or the normal fair

market value that is indicated on the financial statements.

Fixed assets. This category includes all property and equipment owned by the

organization. Fixed assets are generally not sold and the balance sheet does not reflect the

fair market value of the asset or the cost of replacing the items. Instead, the fixed asset line

item includes the net book value of the assets. The net book value is the historical cost of

the long-term assets less depreciation. In general, fixed assets depreciate year to year

because the organization must record a non-cash depreciation expense. This depreciation

often follows the straight- line method, which reduces the asset’s worth by equal annual

increments over the estimated life of the asset. (Keating, 2001, p.32)

Some nonprofits own works of art. Since these assets may not decline in value, a

nonprofit must record them as assets on the organization’s balance sheet. Nonprofits can

choose to capitalize their collections retroactively, and then depreciation need not be taken

because the asset will not be consumed over time. (Olenick, A. & Olenick, P., (1991), p.

352-56).

Balance Sheet Liabilities

Accounts payable. This line item includes unpaid bills from vendors and creditors

for goods and services delivered. If specific items such as wages, taxes, and grants are

significantly large, they can be reported separately or integrated into this line item.

26
 Grants payable. These are grant amounts promised to individuals or other

organizations.

Refundable advances. This is also known as deferred revenue. Included in this line

item are grants received from donors that are not considered or recognized as revenue

because the conditions of the grant have not been met.

Dues to third parties. These are dues transferred to a third party through another

organization. An example is United Way, a federated membership organization which acts

as a transfer agent collecting contributions from one group and disbursing the funds to a

third party. The intermediary party has no power to change the recipient of the funds, so

the funds are considered liabilities.

Long term debt. This is the principal and interest owed to a creditor. Examples of

long-term debt are bank loans, publicly traded bonds, or privately arranged debt financing.

Net Assets (Three categories)

Unrestricted. These are funds unrestricted by the donor.

Temporarily restricted. These are funds that are limited by donor stipulations.

These stipulations can either be met by the actions of the organization or expire over time.

Permanently restricted. These funds are similar to temporarily restricted funds, but

the donor stipulations do not expire over time or by the actions of an organization. An

example of permanently restricted funds is the principle of an endowment. The principle

of the endowment must remain intact into perpetuity (Keating, 2001, p.32).

Operating Statement

A complete set of financial statements includes a third report called the Statement of

Activity, Income Statement or Operating Statement. The operating statement is it a

27
description of how the organization’s net assets or operations have changed over time.

This change in net assets is expressed through the general equation: Revenues – Expenses

= Change in Net Assets (Keating, 1991, p.34). This change in net assets reflects either a

surplus or a deficit.

The operating statement is generally divided into three categories

unrestricted, temporarily restricted, and permanently restricted funds. When an

organization receives funds, or revenues it must then determine the intent of the donor,

which is then reflected and categorized under unrestricted, temporarily restricted, or

permanently restricted funds (Olenick, A. & Olenick, P., 1991, p. 356-58). If a donor

imposes a restriction on the funds the use of the funds are limited. However, the donor

cannot ask for the return of the donation. An asset can be moved from the temporarily

restricted column if the restriction is removed. The asset can then be considered

unrestricted and an organization can use the funds appropriately. As indicated on the

operating statement below, $100,000 were released from the temporarily restricted fund

and moved to the unrestricted category. This change was recorded to indicate that the

money was placed in the correct fund and that the temporary restrictions had been met by

the organization. This allowed it to move the money to the unrestricted column.

Permanently restricted funds cannot be moved unless the time allotted for the funds expires

or the full intent of the donor is carried out by the organization.

A donor may also impose a condition when donating monies. A donation is

considered a liability until the condition is met as the donor requested. The money is

considered a liability because the donation can be rescinded until the condition is met by

the organization. It cannot record the donation as revenue until the condition or liability is

28
eliminated. For example, as seen below, the organization will record the $30,000

permanently restricted funds as a liability on the balance sheet because the conditions of

the donations have not been met by the organization.

Example of an Operating Statement: Operating Statement/Statement of Activities for

ABC Company for Year Ending 2002**
Temporarily Permanently
Changes in Unrestricted Net Assets: Unrestricted Restricted Restricted Total
Revenues and Gains:

Public Contributions (net): $ 600,000.00 $150,000.00 $30,000.00 $ 780,000.00

Program Service Revenue: $ 50,000.00 $ 50,000.00

Investment Income: $ 30,000.00 $5,000.00 $ 35,000.00

Net Assets Released from Restrictions: $ 100,000.00 $(100,000.00) $ 0

Total Revenues, Gains, Other Support: $ 780,000.00 $55,000.00 $30,000.00 $ 865,000.00

Expenses:
Program Services: $ 500,000.00 $ 500,000.00
General Administration: $ 165,000.00 $ 165,000.00
Fundraising: $ 100,000.00 $ 100,000.00
Total Expenses and Losses: $ 765,000.00 $ 765,000.00

Increase in Net Assets: $ 15,000.00 $55,000.00 $30,000.00 $ 100,000.00

Net Assets as Beginning of Year: $ 300,000.00 $0 $500,000.00 $ 800,000.00
Net Assets as End of Year: $ 315,000.00 $ 55,000.00 $ 530,000.00 $ 900,000.00
**Each of the line items on the Operating Statement is described below.

Operating Statement Revenues

Contributions. These are unconditional transfers of assets to a nonprofit,

cancellation of a liability or settlement of a voluntary nonreciprocal transfer. This line item

can include future unconditional promises to pay cash or other assets.

Contributions are recorded at fair- market value when the gift is received. If

contributions are paid in installments, the nonprofit can record only the discounted amount

given, not the gross amount of the gift. The interest compounded over the length of the gift

can be recorded as a gift to the organization. If the organization fears delinquency of

payments, the organization can reduce the value of amount given by the anticipated

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defaults of payments. In-kind goods and services are not generally recorded on the

Operating Statement. Collections do not have to be recorded under revenues in certain

situations, but in-kind professional services can be recorded if the service increases or

creates a non-financial asset.

Program service revenue. This is revenue generated when a nonprofit provides a

service in exchange for cash or another asset.

Membership dues. These are fees or revenue that is generated from members of an

organization for services that the nonprofit provides.

Special events revenue. This is revenue from special events (i.e. fundraising events)

that are recorded separately from contributions. A nonprofit should record the gross

revenue of the event and offset this amount by recording the costs associated under the line

item for fundraising expenses.

Investment income. This is income earned from the investment portfolio. This

includesdividends on stock as well as interest on bonds. GAAP accounting requires that

investment income includes changes in the market value of the investments.

Operating Statement Expenses

Program expenses. These are costs for the delivery of goods and services that are

associated with the organization’s mission.

Fundraising expenses. These are costs associated with publicizing and conducting

fundraising campaigns. These may include: maintaining donor mailing lists, conducting

special fund-raising events, preparing and distributing fund-raising manuals, and other

activities involved in soliciting contributions or memberships.

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 Administrative expenses. These are costs associated with general and managerial

expenses such as oversight, business management, record keeping, budgeting, financing

and related administrative activities.

Budgets

A budget shows an organization’s projected expenses and revenues for a given

period of time. Basic budgeting should be integrated into the organization’s programs and

service to determine planning steps, evaluation methods, pricing for services, timing of

events, and costs related to achieving the organization’s mission. Arnold and Philip

Olenick argue that there are five key steps in budgeting:

1. Expenses are commonly estimated first. This is the simple process of

multiplying the number of people, quantity of supplies, amount of space needed,

etc., by the estimated cost per unit of each such item. Normally, the staff that is

the most familiar with the details handles this process. A tentative expense

budget should then be submitted to the board for review and approval.

2. Potential sources of income are estimated next. People involved in fundraising

including the board best accomplish this. Sources may include: grants, fund

drives, and fees for service, among others.

3. Expenses must be brought into line with reality. An organization must balance

projected income and outgo before a balanced budget can be written.

4. The final proposed budget must then be reviewed and approved by the board

after fine-tuning.

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 5. During the year the budget must be evaluated periodically to determine whether

projected and actual income and expenses are in line. If not, and if the variance

(amounts over or under budget) are substantial the budget must be updated and

revised if it is to be of any use at all (1991, p.83-84).

Estimating revenues for an organization can begin with a general list of the most

common types of income. Dues, individual contributions, and investment income can be

determined by breaking down the total spent on each line per quarter. In estimating for the

upcoming year an organization should factor in the economic climate and the

organization’s anticipated programs. Projected revenue from fees and admissions can be

figured by reflecting on last year’s purchasing patterns. A nonprofit should review the

changes of price and activity in determining the projected revenue from fees and

admissions. As Arnold and Philip Olenick state: “The heart of budgetary control is

studying and investigating the cause of variances between budgeted figures and actual

income and expenses. Fundraising, grants, foundation and government support should be

budgeted conservatively”(1991, p.83). An organization should look at timelines,

restrictions for each contribution, and related expenses attendant to obtaining grants or

other fundraising activities.

Example of Budget by Source ABC Projected Budget Revenues 2004

Estimated Revenues Annual Total

Foundation Grants*
Oprah Winfrey Foundation 250,000
Ned Flanders Grant 500,000
Bourgeois International 100,000
Edwards Arts Focus 250,000
TOTAL FOUNDATION 1,100,000
Government Grants**
NEA 50,000
NEH 25,000

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 ICA 2,700,000
ANYTOWN city govt. 1,300, 000
TOTAL GOVT GRANTS 4,075,000
In-kind contributions 50,000
TOTAL IN-KIND 50,000
Fundraising Events
Be-Humble Auction 200,000
Dance the Night Fundraiser 300,000
Board Fundraising
TOTAL FUNDRAISING 500,000
Revenues
Admission 750,000
Classroom/workshops 100,000
Store sales 75,000
TOTAL REVENUES 175,000
Membership
Superfriend 5,000
Silver Member 3,750
Bronze Member 48,750
Gold Member 11,250
Platinum Member 50,000
Diamond Club 500,000
Everlasting Circle 500,000
Founder's Circle 500,000
TOTAL MEMBERSHIP 1,618,750

Interest Income 10,000

TOTAL INCOME 10,000
TOTAL EST. REVENUE 8,278,750
*These are grants the organization will receive in 2004
** NEA and NEH monies from a three-year grant; the organization has received notification that we will
receive ICA and ANYTOWN grants in 2004.

An organization can estimate expenses by reviewing the planned activities for the

upcoming year. After reviewing projected revenues, an organization should carefully

review the support services needed to implement activities program by program. This

estimate should include: number of individuals needed to carry out the program or activity;

the space and facilities needed to complete the work; costs associated with transportation,

mailings, advertising and other supplies. Finally, an organization can project how much

33
and what kind of resources will be donated as in-kind contributions and other expenses that

may be derived from the specific services offered by the nonprofit.

Example Projected Expenses by Program

ABC Projected Budget Expenses 2004

Budgeted Expenses Annual Total

Program Services
Classroom/workshops 100,000
Teachers salary 200,000
Travel 10,000
Telephone 5,000
Supplies 300,000
TOTAL PROGRAM 615,000

Support Services
Administrative salaries 1,000,000
Computers 200,000
Custodial services 100,000
Payroll fringe benefits 500,000
Travel 20,000
Legal 40,000
Telephone 20,000
Marketing 200,000
Occupancy 200,000
Misc. expenses 50,000
TOTAL SUPPORT 2,330,000

Store Expenses
Merchandise 50,000
Inventory software 5,000
Misc. expenses 1,000
TOTAL STORE 56,000

Fundraising
Special Events 250000
Printing 30,000
Postage 80,000
TOTAL FUNDRAISING 360,000

Building
Structure 4,000,000
Furniture/display materials 500,000
4,500,000
TOTAL BUILDING

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 Collections
Care/Maintenance 100,000
Purchases 50,000
Collection/loan insurance 15,000
Security 15,000
TOTAL COLLECTIONS 180,000

Total expenses before depreciation 8,041,000

Depreciation 89,000
TOTAL EXPENSES 8,130,000
Excess revenue over expenses 148,750
Excess expenses over revenue 0

The two previous budget examples provided in this paper have been based on

funding streams (revenues) and separate program costs (expenses). These are two ways an

organization can compile information for a budget. Other budgeting techniques are can

include flexible budgeting, performance budgeting, cost benefit analysis, zero-based

budgeting, and forecasting.

Flexible Budgeting

Flexible budgeting allows managers the ability to create operating budgets for

various workload le vels. Reviewing the volume of goods and services provided by the

organization suggests the workload of an organization. “If the volume of services, cost of

services, and revenues related to services all rose and fell in equal proportions, this might

not create a significant problem” (Finkler, 2002, p.67). Generally, this does not happen

within an organization and managers need to be able to predict what could happen if

dramatic changes occur with services, expenses, and revenues. A flexible budget provides

a manager the option to understand the impact of various workloads on an organization.

35
Example of a Flexible Budget:
Flexible Budget for ABC Nonprofit 2004

Volume of Participants per Program $ 35,000.00 $ 40,000.00 $ 45,000.00

Revenues*
Donations $100,000.00 $100,000.00 $ 100,000.00
Fees 52,500 60,000 67,500
Total Revenues $187,500.00 $200,000.00 $ 212,500.00
Expenses
Salaries $ 50,000.00 $ 50,000.00 $ 50,000.00
Supplies 70,000 77,000 84,000
Rent 12,000 12,000 12,000
Other 5,000 5.000 5,000
Total Expenses $137,000.00 $144,000.00 $ 151,000.00
Surplus/(Deficit) 50,500 56,000 661,500
*For example purposes only, other revenues streams likely in similar situations.

Performance Based Budgeting

Performance based budgeting focuses on what the organization hopes to

accomplish. (Finkler, 2001, p.68) An organization should use performance budgets in

situations where there is an unclear relationship between outcome s and resources.

Performance budgeting requires the organization to define clear goals and then dedicates

resources to accomplish these goals. In addition, this method will allow the organization to

assess how well it planned to utilize its resources for an intended goal.

Often performance budgets are centered around cost centers. A cost center for an

organization can be a program or service provided by an organization. When an

organization determines if it should use a performance budget the managers should

determine the cost centers and the objectives that will accomplish the intended goals. After

cost centers are established, managers must then consider if the objectives are appropriate

for each cost center, what influence the objectives will have on an entire organization, and

whether the cost center should be continued or discounted.

36
Example of a Performance Based Budget

Performance Based Budget

Performance Type of Activity Output Measure Budgeted Output Total Cost Avg. Cost
Area

Improve Change in specific # of complications 10% reduction $60,000 6000 per 1 %

Quality Performance reduction

Perform education programs number of programs 1000 $50,0000 $50/program

Programs

Improve Staff Allow longer breaks Turnover rate Reduce turnover by $20,000 $10000 /staff
Satisfaction and free coffee/donuts 50% from 6 years member
To 3 years retained

Cost-Benefit Analysis

Cost-benefit analysis compares the costs and benefits of organizations actions or

programs. Usually required by the government agencies cost benefit analyses can also be

used by small nonprofits for special occasions. For example, an organization may want to

purchase a vehicle to service homebound individuals. It can institute a cost-benefit

analysis of purchasing the vehicle by going through a five-step process: determine the

project goals; determine the benefits of the purchase or program goals and determines

project costs; determine the cost and benefit flow at an appropriate rate; and make a

decision analysis based on the data collected. Organizations that utilize performance based

budget or flexible budget along with a cost-benefit analysis can gather more information

and, therefore, make a more informed decision. If the costs seem to high, or the costs

increase dramatically over a long period of time, the organization should decide whether

the project’s intended benefits outweigh the high-cost of the project.

37
Zero-based Budgeting

Each item in an organization’s budget is closely examined to determine its value.

As Steven Finkler states, “Any items that do not add value or do not add sufficient value to

justify their cost should be eliminated from the budget” (p.75). Zero-based budgeting is a

time-consuming process and some organizations only use zero-based budgeting for new or

existing programs, or use zero-based budgeting by rotating it into the organization

budgeting schedule every three to five years.

Forecasting

When an organization plans a budget it must estimate what the revenues and

expenses will be for a certain program and period of time. These predictions or forecasts

can be made from historical data or, if none exists, from similar information garnered from

comparable programs, organizations, or investigative cost-benefit analysis. In addition, an

organization can form committees to research a program.

The basic premise on which to base budgeting revenues and expenses is a well- laid

out plan for the next year. If an organization delivers multiple programs, the staff and board

must determine the viability of each program and the revenues and costs associated with

each. Variances between the actual and the projected budgets that appear throughout the

year will be indicators of change within in the organization. If an organization completes

next year’s budget before the current year has ended, it can closely monitor the growth and

decline of the organization’s net assets.

Conclusion

As Stephen A. Finkler states, “ A good place to commence financial statement

analysis is by carefully and thoroughly reading the financial statements and the

38
accompanying notes” (p.443). There are three predominant themes that should emerge

during the review of statements. First, the organization should determine whether the

financial management of the organization’s finances is meeting the intended mission of the

organization. Second, the analysis should determine the financial stability of the

organization and compare this to overall trends in the nonprofit sector. Third, the financial

statements should show results of the business activity by the organization. These results

should be compared to the intended goals and objectives for the period and time and

deemed acceptable or unacceptable.

Ideally, a yearly audit by a Certified Public Accountant (CPA) is performed to

examine the financial statements and records of a nonprofit organization. After an audit is

complete the CPA will attach an auditor’s opinion letter indicating that the financial

statements have been reviewed and that a certain level of compliance with GAAP

principles has been achieved. An auditor can also aid an organization in reconciling its

books but if severe financial errors are found the management team will be held

accountable by federal and state regulations.

This paper has provided the basic framework of gathering together information for

the balance sheet, operating statement and cash flow statement. It has also reviewed

information on budgeting that will enable an organization to project what expenses and

revenues may be incurred for a given period of time. Such information can form a more

complete picture of the organization’s financial position. Whatever the steps, a thorough

preparation and review of financial statements is of vital importance to the nonprofit’s

continuing fiscal health.

39
 Glossary of Terms

Accountant A professional person who develops and maintains accounting

systems interprets the data and prepares reports, supervises the

work of accounting employees, and participates in management

decisions.

Accounting The process of gathering and preparing financial information

about a business or other organization in a form that provides

accurate and useful records and facilitates .

Accounting cycle The total set of accounting procedures that must be carried out

during each fiscal period.

Accounts payable The money that a business owes to its trade creditors. This

money is a liability of the business.

Accounts receivable The money that is owed to a business by its customers. This

money is considered an asset of the business.

Accrued expense An expense incurred during an accounting period for which

payment is not due until a later accounting period.

Accrual-basis Under the accrua l method of accounting, income is reported in

Accounting the tax year earned, whether or not received, and deductions are

claimed in the tax year incurred, whether or not paid.

Adjusting entry An entry made before finalizing the books for the period to

apportion amounts of revenue or expense to the proper

accounting periods or operating divisions.

40
Asset Anything owned that has a dollar value.

Audit An examination of the accounting records and internal controls

of a business in order to be able to express an opinion about the

business's financial position and results of operation.

Balance Sheet A statement showing the financial position (the assets, liabilities,

and capital) of an individual, company, or other organization on

a certain date.

Bank reconciliation A routine procedure to find out the reasons for a discrepancy

between the balance on deposit as shown by the bank and the

balance on deposit as shown by the depositor.

Bookkeeper A professional who ensures that transactions are properly

recorded and that supporting documents are present and correct.

Carries out routine calculations, reconciliation's and bank

transactions. Records daily business transactions in the

accounting cycle.

Capital The difference between the total assets and total liabilities plus

fund balances of a nonprofit.

Cash-basis Under the cash method of accounting, income is reported in the

Accounting tax year actually or constructively received and expenses are

deducted in the tax year paid.

Chart of accounts A list of the accounts of a business and their numbers, arranged

according to their order in the ledger.

41
Cost of goods sold The total cost of goods sold during an accounting period.

Current assets Unrestricted cash, an asset that will be converted into cash

within one year, or an asset that will be used up within one year.

Debtor Anyone who owes money to the business.

Depreciation The decrease in value of a fixed asset over time. For accounting

purposes, this decrease is calculated according to a

mathematical formula.

Dividend An amount of earnings declared by the board of directors for

distribution to the shareholders of a corporation in proportion

to their holdings, having regard for the respective rights of

various classes of stock.

Drawings A decrease in owner's equity resulting from a personal

withdrawal of funds or other assets by the owner.

Expense A decrease in equity resulting from the costs of the materials

and services used to produce the revenue.

FASB 116 FASB statement No. 116 Accounting for Contributions

Received and Contributions Made. Generally requires the

recording of contributions and pledges received at their fair

market value at the time of receipt.

FASB statement No. 117 Financial Statements of Not-For-

FASB 117 Profit Organizations. Establishes standardized financial

statements for most non-profit organizations and establishes the

42
 requirements for the basic information that must be presented

in order to be in conformity with generally accepted accounting

principles. A new complete set of financial statements must

include the following: a Statement of Financial Position

(formerly Balance Sheet) reports assets, liabilities and net

assets (formerly fund balance). The new reporting requirements

require organizations to present net assets in three

Distinct classes: permanently restricted, temporarily restricted

and unrestricted net assets.

Fiscal Period The period of time over which earnings are measured.

GAAP Generally accepted accounting principles.

General ledger A book or file containing all the accounts of the business other

than those in the subsidiary ledgers. The general ledger

accounts represent the complete financial position of the

company.

Goodwill An intangible asset of a business that has a value in excess of

the sum of its net sales.

Historical Cost An accounting principle requiring all financial statement items

to be based on original cost.

Income An increase in equity resulting from the proceeds of the sale of

goods or services.

43
Income Statement Total incomes and total expenses incurred during a specific

time period, or "fiscal period".

Journal Diary of recording events of financial or operational in nature.

Ledger A group or file of accounts that can be stored as pages in a

book, as cards in a tray, as tape on a reel, or magnetically on

disk.

Liability A debt of an individual, business, or other organization.

Net worth The difference between the total assets and total liabilities of a

business.

Posting The process of transferring the accounting entries from the

journal to the ledger.

Prepaid expense An expense, other than for inventory, with benefits that extend

into the future, paid for in advance.

Retained Earnings The capital that comes from company profits which has not yet

been paid out to shareholders.

Revenue An increase in equity resulting from the proceeds of the sale of

goods and services.

44
Source document A business paper, such as an invoice, that is the original record

of a transaction and that provides the information needed

when accounting for the transactio n.

Trial balance A special listing of all the account balances in a ledger, the

purpose of which is to see if the dollar value of the accounts

with debit balances is equal to the dollar value of the accounts

with credit balances.

Working capital The difference between the current assets and the current

liabilities of a business.

45
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